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The majority of central banks still stimulating their economies

August 4, 2015

Five central banks cut interest rates. Brazil stands on contractionary side, however, clearly signaling the end of the tightening cycle.

In July, there was monetary policy decision in 22 of the 31 countries that we cover. Five central banks cut interest rates, Sweden being the only surprise, reacting to uncertainty in Greece and the appreciation of the crown. Brazil stands again on the contractionary side - clearly signaling the end of the cycle - and now, also does South Africa.

In Latin America ex-Brazil, the expectation of flat interest rates remains unchanged, but central banks are more concerned over the inflation outlook. The region's economy continues to decelerate, but inflation is high in many countries. The recent FX depreciation will likely keep inflation at high levels for a longer period. Among the countries that we cover, we expect rate movements only in Mexico, and not before the first quarter of 2016. But some board members of the Colombian central bank recently voted for hikes.

** Numbers in red indicate rate cuts, in green rate hikes and in grey another monetary policy change different from interest rates.

2. Charts

3. Monetary policy in LatAm

BRAZIL: The Last 50 bps

In July, the Brazilian Central Bank’s Monetary Policy Committee (Copom) once again raised the benchmark Selic interest rate by 50 bps, to 14.25%.The decision was unanimous, and did not surprise given statements from the Copom members made days before the decision.

The highlight was the post-meeting statement, which clearly signaled the Copom’s intention to end the tightening cycle after July’s move, and to keep the Selic at 14.25% for a long period:

“Evaluating the macroeconomic scenario, the outlook for inflation and the current balance of risks, the Copom decided unanimously to raise the Selic rate by 0.50 p.p. to 14.25% p.a., without bias.The Committee understands that maintaining this level of the basic interest rate for a sufficiently long period is necessary for inflation to converge to the target at the end of 2016.”

The Copom retained some small flexibility for futures moves by stating that maintaining the Selic at 14.25% is “necessary” for the convergence of inflation.Since the economic conditions remain volatile, what is “necessary” may not be sufficient (for example, in the case that the exchange rate continues to depreciate, and threatens achieving the inflation target).

After July’s move and statement, we believe the Selic rate will remain at 14.25% for the rest of this year and part of next year.

MEXICO: Stable Policy Rate and Stronger Intervention

As widely expected, Mexico’s central bank left the policy rate unchanged at 3.0%.In the statement announcing the decision, the board noted that the balance of risks for activity deteriorated from the previous meeting, while the balance of risks for inflation improved for the short-term (though the board also noted that they remain high). In the concluding remarks of the statement, the board continues to highlight the weak cyclical conditions of the economy, the low inflation and well-anchored inflation expectations in spite of the recent peso depreciation. However, it again noted that the relative monetary policy stance of Mexico vis-à-vis that of the U.S. is a key variable for future decisions.

Together with the monetary policy decision, the foreign-exchange commission (formed by members of the Central Bank and the Ministry of Finance) announced stronger intervention in the exchange-rate market. The daily sales of dollars with no minimum price will be increased significantly from USD 52 million to USD 200 million (from July 31 to September 30). In addition, authorities reduced the required daily depreciation to trigger the USD 200 million daily auctions with minimum price (the trigger is now 1% depreciation from the previous trading day, instead of 1.5%). So, dollar sales can reach USD 400 million daily (and no less than USD 200 million). We note that board members had previously indicated that they would rather deal with exchange-rate volatility in anticipation to the Fed’s liftoff with intervention, instead of rate hikes.

While there is the risk that the central bank decides to raise interest rates as soon as the Fed starts to increase its own policy rate (the central bank of Mexico changed the calendar for monetary policy decisions, so the board will decide on rates right after the FOMC meetings), we think that the weak growth and record-low inflation will lead the board to hike only in 1Q16, after the Fed’s liftoff and when the benefits of the U.S. recovery on Mexico’s activity are clearer.Also, the more successful intervention is in curbing the weakening of the peso, the higher is the probability of our base scenario for interest rates (we currently see the policy rate ending this year at 3.0% and 4.0% the next).

CHILE: Growing concerns over the inflation outlook

Minutes from the July monetary policy meeting show that the decision to hold the policy rate at 3.0% was unanimous. This was evaluated as the only relevant option. Keeping the policy rate unaltered was the appropriate decision given the downside surprises of activity and the higher-than-expected inflation. While the central bank is not signaling any rate move in the near-term, rate cuts are clearly off the table, as the central bank does not link the economic slowdown to the lack of stimulus. At the same time, the bank still sees the high inflation as a result of transitory factors (the exchange-rate weakening and its spill-over to other prices through indexation mechanisms) so rate hikes are not suitable.

However, the staff expressed concern over inflation expectation risks stemming from the persistence of inflation at high levels, especially considering the recent weakening of the Chilean peso and the possibility of more depreciation ahead given the external scenario.The board still expects inflation to fall to the target center (3.0%), but now more slowly than previously anticipated.

We expect the central bank to keep the policy rate unchanged at 3.0% both this year and the next, as growth remains weak and inflation gradually falls to the target center.However, the persistence of inflation at high levels is clearly concerning the central bank, thus we cannot rule out that additional upside inflation surprises lead the central bank to hike rates.

COLOMBIA: A split board keeps rates on hold

The central bank of Colombia held its policy rate at 4.5% - one month short of a full year on hold - in its July meeting. The decision was widely expected by the market. The press release announcing the decision kept a neutral tone, as has been the case in recent meetings. However, in a surprise turn of events, Governor Uribe conveyed in the press conference that the decision was not unanimous. Specifically, Governor Uribe revealed that “some” of the board’s seven members voted to raise rates. Clearly, these members are concerned with the impact of the further depreciation of the Colombian peso on inflation, which is already at an uncomfortable level.

We expect the Central Bank to remain on hold for the remainder of the year and throughout 2016, as long as inflation expectations for the relevant horizon remain anchored.With the economy cooling down in a low oil price scenario, and the effect of transitory shocks affecting consumer prices fades, inflation would converge to the center of the target by the end of next year. Alternatively, as the current account deficit is notably wide and the liftoff of the FOMC looms, there is little space for additional easing.

PERU: Further Reserve Requirement Cuts Are Unlikely

Peru’s central bank held the policy rate at 3.25% in its July meeting.It is the sixth consecutive meeting at which the board has stayed on hold. The board retained a neutral tone in the statement announcing the decision.

Departing from previous statements, the board made an explicit note of the inflation expectations.For 2016, expectations sit at 2.8%, up from 2.6% in the previous central bank survey, edging closer to the upper bound of the target range. Drawing specific attention to this hints at the central bank's growing concern with the inflation outlook. The central bank had been implementing monetary easing through lowering the reserve requirement rate for local currency, but chose to leave the rate unchanged for July at 6.5%. This tool has been used to increase liquidity and support credit growth, without adding pressures for exchange-rate weakening. However, the additional gains of a lower reserve-requirement rate have diminished, after implementing more than 20 percentage points of cuts in two years.

We do not expect any policy-rate moves during the remainder of the year, or throughout next year, as the central bank finds itself facing, on one hand, high inflation, higher inflation expectations and pressures for exchange-rate depreciation and, on the other, weak activity.Additionally, the probability that the central bank will reduce the reserve requirement rate for local currency further is low.